Earnings season delivered as expected. With 92% of results for S&P 500 Index companies in the books, first quarter 2019 earnings are tracking to roughly flat with the prior year [Figure 1]. While flat earnings don’t sound impressive, we consider it a victory given consensus estimates were calling for a 4–5% decline when earnings season began (source: FactSet). Here, we recap the numbers and provide some key takeaways from earnings season.

GOOD NUMBERS OVERALL

We consider earnings season a success based on the amount of upside to prior estimates generated by S&P 500 companies despite several headwinds. Some numbers that support our assessment include:

Companies generated solid upside to prior estimates of about 5% to get overall earnings up to flat. When earnings season began, consensus estimates called for a 4–5% decline in S&P 500 earnings. An upside of this size, which is slightly above the long-term average, is impressive considering persistent trade uncertainty.

Currency may have been as much as a two percentage-point drag on overall earnings growth, suggesting companies have more earnings power than the overall growth number suggests.

The median stock in the S&P 500 has grown earnings several percentage points faster during the first quarter than the aggregated market-cap weighted measure. According to data from Credit Suisse, the median S&P 500 company is tracking to a 5.6% earnings gain. A few large companies are having outsized impacts, including Apple
(AAPL), whose earnings per share (EPS) dropped 18% from the year-ago quarter.

Estimates have held up well during earnings season. Since April 15, the 2019 consensus estimate for S&P 500 EPS has risen slightly to $168. We consider that a win given that estimates typically fall during earnings season. Consensus S&P 500 earnings estimates for the next 12 months have increased from $173 to $175 per share since mid-April [Figure 2], reflecting expectations for a ramp-up in growth later this year and into 2020.

BEYOND THE NUMBERS

Based on first quarter numbers and the changes to forward estimates, earnings results have been good. Here are some of our key takeaways that go beyond the numbers:

It looks like an earnings recession will be averted. Even if we have an earnings recession (commonly defined as two consecutive quarters of year-overyear earnings declines), it would be extremely shallow. Although earnings may be flat in the first half of the year, we expect some acceleration in the second half.

Tariffs are a huge wild card. If the latest round of tariffs remain in place and are followed by another round—meaning that tariffs would be imposed on all U.S. imports from China—then achieving any earnings growth at all this year will be difficult. It is apparent that the latest escalation of trade tensions caught management teams off guard, which means there is probably some downside risk to current estimates in the event of a prolonged impasse (though that is not our base case).

Slower growth overseas—in the Eurozone and China in particular—has weighed on the results of U.S.-based multinationals. According to FactSet data, earnings growth for companies generating more than half of their revenue within the United States has been 6.2%, compared with a 12.8% earnings decline for companies that generate less
than half of their revenue within the United States.

Operating efficiency has become increasingly important. Companies must consider shifting supply chains away from China as tariffs are imposed. As costs increase, particularly wages, passing along higher tariff costs will become more difficult. This additional potential pressure on profit margins may cap the amount of earnings growth
companies can achieve this year.

Our base case still calls for some upside to the 3–4% consensus estimates for S&P 500 earnings growth in 2019. However, hitting our 6–7% forecast published last fall may be a stretch if the United States and China are unable to resolve their differences within the next several months. Until then, tariffs could eat away at company profit margins, and business leaders may become more cautious with their capital investment decisions. Lower capital spending means less revenue and profits for corporate America.

CONCLUSION

We consider first quarter earnings season a success based on the upside to prior estimates and resilience of estimates for the rest of this year. It appears an earnings recession has been averted and better days lie ahead for U.S. companies. However, the threat of more tariffs is a huge wild card.

We are hopeful that significant progress can be made on the trade front next month, when President Trump and China’s President Xi are expected to meet at the G20 summit in Japan. A prolonged impasse that lasts through the summer would introduce downside risk to our 2019 S&P 500 earnings growth target of 6–7%.

Our base case remains that we will get a trade deal with China early this summer and consensus expectations for 3– % earnings growth may prove to be conservative. Earnings are hardly booming, but with a continued economic expansion, low inflation, and low interest rates, we see enough earnings growth ahead to push stocks up to our year-end S&P 500 fair value target of 3,000—though it probably won’t get there in a straight line.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

All company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities.

DEFINITIONS

Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability. Earnings per share is generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings valuation ratio.

Forward price to earnings (Forward P/E) is a measure of the price-to-earnings ratio (P/E) using forecasted earnings for the P/E calculation.

INDEX DESCRIPTIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The modern design of the S&P 500 stock index was first launched in 1957.

Performance back to 1950 incorporates the performance of predecessor index, the S&P 90.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

If you are receiving investment services out of a bank or credit union, please note that this financial institution is not a registered broker/dealer, and is not an affiliate of LPL Financial. The investment products sold through LPL Financial are:

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

]]>https://salleywealthmanagement.com/earnings-season-takeaways-weekly-market-commentary-may-20-2019/feed/0A Step Back On Trade | Weekly Economic Commentary | May 20, 2019https://salleywealthmanagement.com/a-step-back-on-trade-weekly-economic-commentary-may-20-2019/
https://salleywealthmanagement.com/a-step-back-on-trade-weekly-economic-commentary-may-20-2019/#respondTue, 21 May 2019 04:08:00 +0000https://salleywealthmanagement.com/a-step-back-on-trade-weekly-economic-commentary-may-20-2019/Even in the worst-case scenario, we don’t expect a significant impact on the U.S. economy.

Investors aren’t quite out of the woods yet with trade tensions. On May 5, President Trump threatened to raise tariffs to 25% (from 10%) on $200 billion in Chinese imports, surprising investors who thought the United States and China were close to a deal just a few weeks ago. Five days later, the U.S. announced it would impose higher rates on that swath of goods, and China announced its own tariff increase on $60 billion in U.S. goods. Now, the U.S. is considering higher tariffs on all Chinese imports.

Financial markets have struggled to process the rapid back-and-forth between both countries. The S&P 500 Index fell nearly 5% over six trading days before paring about half those losses through the end of last week. As the stock market swings, we suggest investors step back and consider the fundamental implications of increasing tariff rates. Higher tariffs can weigh on economic activity, but we don’t expect an escalation to derail this expansion [Figure 1].

MANAGEABLE IMPACT

The United States and China have been engaged in a year-long squabble over trade relations as the U.S has attempted to negotiate greater protection fordomestic intellectual property. While an agreement would be beneficial over the longer term, getting to a compromise has involved some short-term risks.

Any direct economic impact from these new tariffs should be small, although the secondary impacts on sentiment and financial markets remain a concern. The United States’ decision to hike rates on $200 billion in Chinese imports adds about $30 billion in costs per year (on top of existing tariffs). U.S. importers pay the direct cost, and some of those costs may be passed on to U.S. wholesalers or consumers. Chinese exporters can also choose to lower prices, but the evidence points to minimal movement in that direction so far. If the U.S. takes the next step and decides to implement a higher tariff rate on all Chinese imports, the U.S. economy would bear about $80 billion in additional costs over a year, which is about 15% of our gross domestic product (GDP) growth projection this year. While this is still a possibility, it would be an unusually aggressive step after several weeks of progress in trade talks. In either case, we expect the fiscal stimulus tailwind alone to overpower any negative effects.

Of course, the past several months have shown that the intangible effects from trade uncertainty can also be significant. Trade tensions have had a chilling effect on consumer and business confidence, and the U.S. economy has only recently begun to overcome a noticeable hit to spending and demand. Growth in capital expenditures is a key part of our economic outlook this late in the business cycle, and prevailing uncertainty could impede this source of future growth.

We continue to project GDP growth near 2.5% in 2019. In the worst-case scenario, we suspect this latest round of tariff increases could lead to a 0.5% reduction in that projection. If that happens, GDP growth would be closer to 2% this year, largely consistent with the average pace over the last decade.

INFLATION IMPLICATIONS

Logically, tariffs should be a catalyst for higher inflation, as higher costs should boost price growth. So far, we’ve seen the opposite happen. Import price growth has slowed considerably: In April, import prices (excluding petroleum) fell 1% year over year, the biggest drop in nearly three years. Consumer price growth has moderated as well, fueling calls for a Federal Reserve (Fed) rate cut to give inflation an extra nudge. So far, the negative impact of slower global growth on inflation has outweighed any broad price impact from tariffs, although inflation has been rising on goods facing tariffs [Figure 2].

Many of the current tariffs are on intermediate goods, and U.S. businesses have struggled to pass along higher input costs to the end consumer, especially amid weaker spending and activity. The U.S. dollar’s recent climb has also helped curb costs for importers. Even if prices rise on Chinese imports, a strong dollar can offset that increase. Given these moving parts, it’s tough to predict how the latest tariff increases will affect U.S. inflation. On balance, though, we think higher tariffs could eventually fuel higher consumer prices, especially if the U.S. ends up raising rates on the other $300 billion in Chinese goods. If the dollar weakens, we could also see some added inflationary pressure.

Economic fundamentals also point to building pricing pressures. We believe wage growth greater than 3% should eventually stoke higher consumer inflation, as wages constitute about 70% of business costs. Consumer inflation was near the Fed’s 2% target for most of 2018, and we expect a return to these levels once trade uncertainty is resolved.

CONCLUSION

U.S.-China trade negotiations are in a delicate stage, and we expect more brief bouts of increased uncertainty as the two sides tackle difficult remaining issues. Still, we don’t think trade tensions will materially dent U.S. economic growth. While there is increased uncertainty, we still expect a deal over the next several months. Late stages of negotiation can be the most challenging as both sides push for final concession, but we still largely view this as part of the negotiating process and not a fundamental change in intent. The bottom line is that a deal is clearly in the best interest of both parties. President Trump wants re-election and a strong economy, China wants growth, and neither party wants to materially roil global financial markets. But U.S. companies doing business with China do need to come away with greater enforceable protection of intellectual property. Tensions are high, but we believe a path to compromise still exists.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted.

Investing involves risk including loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

If you are receiving investment services out of a bank or credit union, please note that this financial institution is not a registered broker/dealer, and is not an affiliate of LPL Financial. The investment products sold through LPL Financial are:

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

]]>https://salleywealthmanagement.com/a-step-back-on-trade-weekly-economic-commentary-may-20-2019/feed/0Portfolio Compass | May 16, 2019https://salleywealthmanagement.com/portfolio-compass-may-16-2019/
https://salleywealthmanagement.com/portfolio-compass-may-16-2019/#respondFri, 17 May 2019 03:34:16 +0000https://salleywealthmanagement.com/portfolio-compass-may-16-2019/We expect a transition to large cap market leadership and away from small cap stocks in 2019
as the economic cycle ages.

INVESTMENT TAKEAWAYS

With the S&P 500 Index near our year-end fair value target of 3,000, coupled with the slightly softer economic and profit growth outlook, we believe a market weight recommendation for U.S. equities is prudent. Escalating trade tensions remain the key risk.*

We maintain our slight preference for value due to attractive relative valuations after a sustained period of growth outperformance.

We expect a transition to large cap market leadership and away from small cap stocks in 2019 as the economic cycle ages.

We favor emerging markets (EM) equities for their solid economic growth trajectory, favorable demographics, attractive valuations, and our continued expectation that the United States. and China will reach a trade agreement in the coming months.

Slower but still solid economic growth and modest inflationary pressure may be headwinds for fixed income. The pause by the Federal Reserve (Fed) reduces near-term upward pressure on interest rates, but an additional hike is still possible in the second half of 2019.

We emphasize a blend of high-quality intermediate bonds, with a preference for investment-grade corporates (IGC) and mortgage-backed securities (MBS) over Treasuries. MBS provide a diversifying source of yield within the investment-grade space, while economic growth is supportive of IGCs.

The S&P 500 Index recorded fresh record highs within the past month, officially keeping the bull market alive. However, the seasonally weak period and lack of significant pullback since the December lows give technical confirmation to our market-weight stance for U.S. equities.

All performance referenced is historical and is no guarantee of future results. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to effect some of the strategies.

All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Stock and Pooled Investment Risks

The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential illiquidity of the investment in a falling market.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

The prices of small and mid cap stocks are generally more volatile than large cap stocks.

Bond and Debt Equity Risks

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Alternative Risks

Event-driven strategies, such as merger arbitrage, consist of buying shares of the target company in a proposed merger and fully or partially hedging the exposure to the acquirer by shorting the stock of the acquiring company or other means. This strategy involves significant risk as events may not occur as planned and disruptions to a planned merger may result in significant loss to a hedged position.

Managed futures strategies use systematic quantitative programs to find and invest in positive and negative trends in the futures markets for financials and commodities. Futures and forward trading is speculative, includes a high degree of risk that the anticipated market outcome may not occur, and may not be suitable for all investors.

INDEX DEFINITIONS

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Bloomberg Barclays U.S. Municipal Bond Index covers the U.S. dollar-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and prerefunded bonds.

A cyclical stock is an equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies that sell discretionary items that consumers can afford to buy more of in a booming economy and will cut back on during a recession.

Duration is a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. It is expressed as a number of years. Rising interest rates mean falling bond prices, while declining interest rates mean rising bond prices. The bigger the duration number, the greater the interest rate risk or reward for bond prices.

Credit ratings are published rankings based on detailed financial analyses by a credit bureau specifically as it relates to the bond issue’s ability to meet debt obligations. The highest rating is AAA, and the lowest is D. Securities with credit ratings of BBB and above are considered investment grade.

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

The simple moving average is an arithmetic moving average that is calculated by adding the closing price of the security for a number of time periods and then dividing this total by the number of time periods. Short-term averages respond quickly to changes in the price of the underlying, while long-term averages are slow to react.

The Beige Book is a commonly used name for the Federal Reserve’s (Fed) report called the Summary of Commentary on Current Economic Conditions by Federal Reserve District. It is published just before the Federal Open Market Committee (FOMC) meeting on interest rates and is used to inform the members on changes in the economy since the last meeting.

Technical analysis is a methodology for evaluating securities based on statistics generated by market activity, such as past prices, volume and momentum, and is not intended to be used as the sole mechanism for trading decisions. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns and trends. Technical analysis carries inherent risk, chief amongst which is that past performance is not indicative of future results. Technical analysis should be used in conjunction with Fundamental analysis within the decision-making process and shall include but not be limited to the following considerations: investment thesis, suitability, expected time horizon, and operational factors, such as trading costs are examples.

The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower PE ratio.

Alpha measures the difference between a portfolio’s actual returns and its expected performance, given its level of risk as measured by Beta. A positive (negative) Alpha indicates the portfolio has performed better (worse) than its Beta would predict.

Beta measures a portfolio’s volatility relative to its benchmark. A Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggests the portfolio has historically been less volatile than its benchmark.

Idiosyncratic risk can be thought of as the factors that affect an asset such as a stock and its underlying company at the microeconomic level. Idiosyncratic risk has little or no correlation with market risk, and can therefore be substantially mitigated or eliminated from a portfolio by using adequate diversification.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

If you are receiving investment services out of a bank or credit union, please note that this financial institution is not a registered broker/dealer, and is not an affiliate of LPL Financial. The investment products sold through LPL Financial are:

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

U.S.-China trade tensions escalated last week. President Trump increased tariffs on $200 billion of Chinese imports to the United States from 10% to 25% and has threatened to put 25% tariffs on an additional $325 billion of Chinese goods—a process that could begin this week, though it would take a couple of months to implement. Stocks reacted as you would expect, falling 2.1% over the five trading sessions. It could’ve been worse, but the S&P 500 Index gained 0.4% on Friday after Treasury Secretary Steven Mnuchin reported that talks on Thursday and Friday were constructive. Though this slide could certainly go further (and is, as of the morning of May 13), it has been quite modest to this point. In fact, as of its close May 10, the S&P 500 had not experienced more than a 3% pullback yet this year. Even with Monday morning’s losses, the index sits only about 4% from its record closing high of 2945.83 on April 30, 2019. Here, we put this pullback in perspective and discuss prospects for a trade deal in light of the events of the past week.

PULLBACK IN CONTEXT

Last week’s selloff was not very big, but it felt worse because of how quickly it happened (and at the intra-day lows, stocks were down more than 3%).

Some context here is helpful. Stocks have come pretty far pretty fast. Erasing corrections near or more than 20% in four months is very rare (the fourth quarter 2018 correction was within an eyelash of the 20% mark). In fact, 1998 was the last time this occurred, and before that, you have to go back to 1982.

Swift rallies like this have also tended to lead to drawdowns as stocks typically have
lost steam midyear (as discussed in our recent “Sell in May” commentary). When
the S&P 500 has been up over 14% year to date through April, as it was this year, the average peak-to-trough decline over the next six months has been 14%.

U.S. stocks were due some volatility. On average, the S&P 500 has pulled back 5% or more three to four times each year, and we are still working on our first one for 2019.

Since 1970, the S&P 500 has made it through the first five months of the year without at least a 3% pullback only twice—in the historically calm years of 1995 and 2017 [Figure 1]. On average the peak-to-trough pullback has been 8.5% during the first five months of the year.

Bottom line, this pullback has been modest, and a bit more volatility in the near term would be normal, even though we believe fundamentals remain solid.

SECTOR DYNAMICS

Last week’s sector performance clearly reflected the concern about trade, with the global industrials, materials, and technology sectors pacing the weekly decline in the S&P 500 [Figure 2]. These sectors
have among the highest percentages of international revenues, particularly China.

Materials have a lot at stake given that China has reportedly offered significant agriculture purchases as part of a potential agreement. Copper prices fell 1.5% last week, reflecting fears of weaker Chinese demand if tariffs remain in place.

Specific industry groups within industrials and technology have high exposure to China, such as aerospace and defense, machinery, and electrical equipment within the industrials sector. Strategas Research Partners highlighted Boeing (BA), Cummins (CMI), Emerson (EMR), and Ingersoll-Rand (IR) as industrial companies with above-average China
exposure and active China lobbying efforts.

We continue to favor financials, industrials, and technology. Industrials and technology are well positioned to benefit from a trade deal. Any potential pickup in economic growth resulting from a trade deal should help financials through more lending, higher asset prices, and a potentially steeper yield curve (a wider spread between shortterm and long-term interest rates).

WHY WE REMAIN OPTIMISTIC

Last week’s headlines were unsettling, and clearly increased the odds of a prolonged trade war with China. While President Trump’s latest moves caught us—and clearly markets—off guard, these developments have not changed our expectation that a deal is forthcoming. It may take a few more months, and market volatility may become the norm.
It’s impossible to know how far both sides are willing to go to get a better deal.

We remain optimistic for the following reasons:

President Trump cares about the stock market. He considers it his report card.

President Trump wants to be re-elected. A strong economy and healthy stock market are key components of his path to re-election.

Both the United States and China have a lot to lose in a prolonged trade war. The relationship is symbiotic.

The United States and China almost reached a deal earlier this month. We do not dismiss the risk of a longer stalemate, but reports that indicated a deal was very close tell us it is reasonable to think the remaining sticking points can be worked out.

CONCLUSION

We’re not totally dismissing the possibility of a prolonged trade war, but we think cooler heads will eventually prevail. We may have to tolerate more volatility in the near term while President Trump and Chinese President Xi pursue a new path to compromise, and tariffs may remain in place for a while so President Trump can show he’s playing hardball, while China can show it is willing to walk away.

We maintain our year-end S&P 500 fair value target of 3,000, about 4.0% from May 10’s close. That target is based on a price-to-earnings ratio of 17.5 and our 2019 S&P 500 earnings forecast of $172.50. We continue to position portfolios with a market weight equities allocation with stocks near our target even after last week’s decline and with the possibility of a pickup in volatility. We would be buyers on any material weakness assuming fundamentals remain consistent with what we see today.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted.

Investing in stock includes numerous specific risks including the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

Because of its narrow focus, specialty sector investing, such as healthcare, financials, or energy, will be subject to greater volatility than investing more broadly across many sectors and companies.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

All investing involves risk including loss of principal.

All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

All company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities.

INDEX DESCRIPTIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The modern design of the S&P 500 stock index was first launched in 1957.

Performance back to 1950 incorporates the performance of predecessor index, the S&P 90.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

Recently, the U.S. economy has shown resilience in powering through political and trade noise. One of the most encouraging reports of late was on productivity (output per hour worked) among nonfarm employees. First quarter productivity rose at the fastest year-over-year pace since 2010, while unit labor costs grew at the slowest pace since 2013.

Growth in productivity is a key part of our economic outlook. Higher productivity boosts both consumer and corporate well-being, feeds into gross domestic product growth, and helps promote healthy inflation. A resurgence in productivity could provide the U.S. economy a timely boost, especially as many wonder what could extend this near-record expansion [Figure 1].

BOOSTING OUTPUT

Productivity has been a crucial piece of past economic expansions. Historically, productivity growth has typically spiked in the beginning of each economic cycle before tapering off later. The current economic expansion has been abnormal, though, as significant productivity growth has been absent for most of the past several years. Productivity has risen at an average pace of 1.3% year over year this cycle, about half of the 2.6% year-over-year growth from the beginning of 2000 to June 2009.

We’ve said for a while now that conditions are ripe for increased productivity, and we’ve seen a modest uptick over the last 12 months—including last quarter’s surprisingly strong reading. Companies are now sitting on record cash piles, and a tight labor market with cycle-high wage growth is forcing businesses to invest in their employees’
development instead of looking for new hires. Higher productivity is an especially important priority for U.S. companies as profit growth plateaus. Operating margins in this expansion have largely benefited from accelerating profits, but we think this tailwind could slow as the cycle matures and growth moderates. Going forward, companies
will have to prioritize capital expenditures (capex) for fueling output, and capex is a primary catalyst
for productivity.

We’ve seen flickers of higher capex over the past couple of years [Figure 2]. Growth in new orders for nondefense capital goods (our favorite proxy for capex) surged from 2017 through the middle of 2018 as profits grew and fiscal stimulus incentivized corporate investment. Then, the U.S.-China trade dispute escalated, derailing the upward trend in business spending.

Although corporate fundamentals remained solid over this period, heightened trade tensions forced U.S. corporations to put spending plans on hold as the economy weathered a slide in demand. Manufacturing health gauges have declined, business sentiment has fallen to a multiyear low, and capex growth has moderated.

Trade tensions remain, despite progress in trade talks, and business sentiment is still fragile. The National Federation of Independent Business’s gauge of small business optimism has hovered around a multiyear low since January, and respondents’ capital expenditure plans have taken a noticeable hit. However, we still think the United
States and China are working toward a deal, and we don’t expect tariffs themselves to significantly impede economic activity. The lingering threat has added the chilling effect of uncertainty, which we think will dissolve with meaningful progress in trade talks. Once there is more clarity on trade, we expect capex to pick up again as companies take advantage of fiscal incentives, record cash piles, and low borrowing costs.

HEALTHY INFLATION

Inflation has been a focal point of U.S. economic data recently. The Federal Reserve is eyeing wage and pricing pressures as it determines the future path of monetary policy. Inflationary threats have also stifled growth in past expansions, so inflation is crucial in gauging economic health. Productivity indirectly influences inflationary pressures. Higher productivity leads to higher wages: Workers tend to get paid more when the value of an hour of work rises. Modestly accelerating wages boost incomes and empower the U.S. consumer, which could fuel faster growth in consumer spending.

However, productivity provides an added benefit of keeping employer expenses in check by reducing the cost of producing output (measured by unit labor costs). If workers are paid more for making widgets, but they can make more widgets in an hour, the cost to businesses for making widgets can be kept contained. Wages alone account for
about 70% of business costs, so it’s difficult to have an inflationary threat without the participation of wages.

Currently, the overarching concern is that inflation is too low. Wage growth, though, has eclipsed 3% year over year for the past several months. In our view, this is a sweet spot for wage growth, as it’s moderate but below the 4% wage growth that has preceded past recessions. As the labor market tightens, we expect wage growth to rise.
Increasing productivity could help temper the cost of higher wages for companies.

CONCLUSION

Even in the midst of a healthy expansion, the U.S. economy’s growth potential has been hindered by muted productivity growth. The first quarter jump in productivity gave us hope that the recent surge in capex and building labor market pressure could be flowing through to output and wages. Trade tensions have been a wild card for U.S. companies, but we expect progress on the trade front to resume. As global uncertainty dies down, corporations should be able to focus more on expansion plans.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted.

Investing involves risk including loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

]]>https://salleywealthmanagement.com/the-power-of-productivity-weekly-economic-commentary-may-13-2019/feed/0Market Insight Monthly | April 2019https://salleywealthmanagement.com/market-insight-monthly-april-2019/
https://salleywealthmanagement.com/market-insight-monthly-april-2019/#respondTue, 14 May 2019 04:17:44 +0000https://salleywealthmanagement.com/market-insight-monthly-april-2019/Green shoots appeared in U.S. economic data as the economy entered the second quarter.

Green shoots appeared in U.S. economic data as the economy entered the second quarter.

Leading indicators signaled low odds of a recession in the coming year. The Conference Board’s Leading Economic Index (LEI) rose 3.1% year over year in March, breaking a five-month slide in annual growth.

Jobs data at the beginning of April confirmed that signs of labor market weakness earlier in the year were temporary. Nonfarm payrolls growth exceeded estimates, while the unemployment rate held steady near a cycle low. Overall, the U.S. labor market remained robust for this point in the cycle, with no apparent sign of the rapid slowing that has often occurred before the onset of a recession.

However, wage and producer price growth remained steady, signaling pricing pressures continued to build. Average hourly earnings grew 3.2% year over year, a level of growth that should continue to bolster consumer confidence and support consumer spending. The core Producer Price Index (PPI), which excludes food and energy prices, rose 2.6% year over year in March.

U.S. manufacturing reports sent mixed signals about the health of the sector in March. The Institute for Supply Management’s (ISM) manufacturing Purchasing Managers’ Index (PMI), a gauge of U.S. manufacturing health, rebounded slightly after hitting a new low in February. Markit’s PMI declined to a 21-month low in March, but preliminary data for April showed a slight rebound in manufacturing activity.

Consumer and business spending data ticked up, though confidence gauges deteriorated further, reflecting U.S. consumers’ and businesses’ uncertainty amid global headwinds. Retail sales rose 1.6% in March, its biggest monthly gain since September 2017, while new orders for nondefense capital goods grew 1.3% in March, the biggest monthly rise since July 2018, according to preliminary data. However, the Conference Board’s Consumer Confidence Index slid in March, while the National Federation of Independent Business’s (NFIB) measure of business confidence was unchanged near a two-year low.

ECB, Bank of Japan Keep Rates Unchanged

The Fed took a break from rate changes prior to its next policy meeting, scheduled to conclude May 1. The European Central Bank (ECB) announced April 10 that it would leave rates unchanged and reiterated its plans to hold rates through 2019. The ECB noted concerns around trade uncertainty and Brexit, and policymakers reportedly discussed plans to provide more stimulus if economic growth in the region doesn’t improve. The Bank of Japan (BoJ) also kept rates unchanged at historically low levels in an April 25 announcement and pledged to keep rates low until at least the spring of 2020.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security.

To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted. All performance referenced is historical and is no guarantee of future results.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

If you are receiving investment services out of a bank or credit union, please note that this financial institution is not a registered broker/dealer, and is not an affiliate of LPL Financial. The investment products sold through LPL Financial are:

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

]]>https://salleywealthmanagement.com/market-insight-monthly-april-2019/feed/0Sell In May? | Weekly Market Commentary | May 6, 2019https://salleywealthmanagement.com/sell-in-may-weekly-market-commentary-may-6-2019/
https://salleywealthmanagement.com/sell-in-may-weekly-market-commentary-may-6-2019/#respondTue, 07 May 2019 04:08:59 +0000https://salleywealthmanagement.com/sell-in-may-weekly-market-commentary-may-6-2019/The May through October period has historically been the weakest six months for equities.

“Sell in May and go away” is probably the most widely cited stock market cliché in history. Every year a barrage of Wall Street commentaries, media stories, and investor questions flood in about the popular stock market adage. This week, we tackle this commonly cited seasonal pattern, and why some seasonal weakness could make sense in 2019.

THE WORST SIX MONTHS OF THE YEAR

“Sell in May and go away” is the seasonal stock market pattern in which the six months from May through October are historically weak for stocks, with many investors believing that it’s better to avoid the market altogether by selling in May and moving to cash during the summer months.

As Figure 1 shows, since 1950 the S&P 500 Index has gained 1.5% on average during these six months, compared with 7% during the November to April period. In fact,out of all six-month combinations, the May through October period has produced the worst average return.

Taking things a step further, we found that stocks pull back from peak to trough an average of 11.1% during these worst six months. With the S&P 500 up 25% from the December lows, we do think the potential for a correction of that magnitude is possible.

WHAT HAVE YOU DONE FOR ME LATELY?

As we head into this seasonally weak period, keep a few things in mind. First, the S&P 500 has closed higher during the month of May six consecutive years—so “Sell in June” might be more appropriate. Not to mention these “worst six months” have been higher six of the past seven years. The point is that investors shouldn’t necessarily blindly sell May 1, but rather be aware that volatility tends to happen in the summer and fall months. For instance, last year the S&P 500 closed higher in May, June, July, August, and September, and then lost 7% in October for the worst monthly drop in nearly seven years.

Also consider the four-year presidential cycle. The previous two pre-election years saw substantial pullbacks during these worst six months. In 2011, the S&P 500 lost nearly 20% after the U.S. debt downgrade in August of that year. Then in August 2015, the Dow Jones Industrial Average had its first ever 1,000-point drop on Chinese currency and economic concerns. Considering the S&P 500 is near all-time highs and up more than 25% from the December lows, more volatility could be forthcoming. Figure 2 shows what the S&P 500 has done on average the past 20 years. It is quite clear that the majority of the gains have tended to happen early and late in the year. It is the middle part of the year when things have tended to get quite choppy.

WHAT DOES A BIG START TO THE YEAR MEAN?

As we noted last week, new highs have tended to resolve with above-average returns in the longer term, but a pullback near term is possible. And we have to mention the list of near-term potential worries that could produce some skittishness: a disagreement with China over trade as the finish line for a deal nears (this risk surfaced over the weekend), possible U.S. tariffs on European autos, Brexit and other structural challenges in Europe, prescribed defense spending cuts, the federal debt ceiling, and a possible late-year rate hike from the Federal Reserve.

Sometimes though, it could be as simple as a big start to a year makes stocks more susceptible to a pullback. As Figure 3 shows, the previous five times the S&P 500 was up more than 14% during the first four months of a year, we saw below average returns during the usually weak May to October period. In fact, only once did stocks rise during those six months, with substantial peak-totrough pullbacks occurring three times. With the S&P 500 up 17.5% this year as May began, history has shown that substantial gains over the next six months might be tough to come by.

CONCLUSION

We’re entering the historically worst six months of the year for stocks, but that doesn’t mean investors should simply sell and buy back in after Halloween.

Potential catalysts for a sell-off are growing, and various events have sparked large corrections in recent years. It is important to note, however, that a correction is just that — a correction. We continue to think the fundamentals support continued economic growth. Case in point: On May 2, first quarter productivity rose at the fastest year-over-year pace since 2010. Higher productivity helps to offset rising labor costs, which can help mitigate inflationary pressures and support healthy profit margins for U.S. companies — thus extending this nearly 10-year-old economic cycle.

We believe there are enough potential positive catalysts to possibly push the S&P 500 through our year-end fair value target of 3,000 this year. But it won’t be a straight line. We recommend a market weight equities allocation, as a seasonal correction is quite likely over the coming months. We would be buyers on any material weakness, as long as the fundamentals remain consistent with continued economic expansion.

IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all
market environments.

All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges.

Index performance is not indicative of the performance of any investment.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

DEFINITIONS

Gross domestic product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments, and exports less imports that occur within a defined territory.

Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. EPS serves as an indicator of a company’s profitability. Earnings per share is generally considered to be the single most important variable in determining a share’s price. It is also a major component used to calculate the price-to-earnings valuation ratio.

INDEX DESCRIPTIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The modern design of the S&P 500 stock index was first launched in 1957. Performance back to 1950 incorporates the performance of predecessor index, the S&P 90.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

Once again, the Federal Reserve (Fed) and the markets are at odds with each other. The Fed announced it would keep rates unchanged at the conclusion of its most recent policy meeting on May 1, and Fed Chair Jerome Powell delivered comments that mirrored what he’s said for the past few months.

Still, bond markets are staunchly positioned for a lower fed funds rate, even as economic data have shown signs of recovery. Fed fun futures are pricing in more than a 50% chance of a rate cut in 2019, and short-term yields have dropped below the upper-bound fed funds rate for the first time this cycle. While investors are literally buying into this possibility, we see the Fed’s continued pause as the most prudent approach [Figure 1].

SLOWING INFLATION

Investors’ main worry seems to be inflation, based on the markets’ reaction to Powell’s post-meeting press conference. Powell repeated several times that further patience is appropriate because inflation has slowed due to transitory factors, such as apparel prices, airfares, and market-sensitive fees in investment management. But that patience, which soothed stocks earlier this year, spurred a 1% intraday sell-off in the S&P 500 Index.

Nervousness around the state of inflation is understandable. Consumer inflation has weakened since the Fed last hiked rates in December. Core personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, rose 1.6% year over year in March, its slowest pace of growth in 18 months. While that pace isn’t alarmingly slow, the downward trend runs counter to the Fed’s intentions.

Markets think the grace period for a “transitory” excuse has passed, but Powell has a point. Most inflation data are current through the end of the first quarter, which was fraught with global economic volatility. Policymakers haven’t seen enough data to get a clear reading on the state of U.S. inflation without the impact from global turmoil, which has eased in recent weeks. Powell also correctly noted that core PCE growth stayed close to 2% for much of 2018, so fundamentals before the first quarter volatility supported the Fed’s inflation target.

Other measures of inflation also point to higher pricing pressures ahead. Powell cited the Fed Bank of Dallas’ “trimmed mean” PCE measure as evidence of this. The trimmed mean PCE, which has proven to be a less volatile version of core PCE, has hit 2% year-over-year growth for the past several months [Figure 2]. Wages, which account for about 70% of business costs, and producer prices have grown at cycle-high paces during this period.

TRACK RECORD

It’s tough to make a case for lower rates with over 3% gross domestic product growth, healthy wage growth, and a labor market close to full
employment. Based on recent history, there has been a high bar for a rate cut (and rightfully so).

The Fed has cut rates 42 times since 1990, with the last rate cut happening in December 2008. Only nine rate cuts occurred after a quarter with output growth of 3% or more. In all of those instances, either leading indicators signaled impending weakness because of market crises, or unemployment was stubbornly high. Neither of these conditions fit today’s environment. Leading data point to a rebound from a somewhat-soft first quarter, and the April jobs report showed robust job creation and cycle-low unemployment.

If consumer inflation picks up, the U.S. economy will be near full employment with healthy inflation across the board, fulfilling the Fed’s dual mandate. Global stability is also of concern, but the lack of clarity and stable domestic growth both support a wait-and-see approach. We’d also expect more warning if the Fed does change course in policy. Between December and January, Fed officials changed their tone in public communication and worked more flexibility into their messaging. Looking back, we now know they were prepping investors for the pause in rate hikes announced three months ago. If the Fed anticipates moving rates in either direction, policymakers will likely work signals into their communications to avoid a market shock from a surprise announcement.

IOER “CUT”

Policymakers did cut one rate at this last meeting, but don’t read too much into it. The Fed reduced its interest rate on excess reserves (IOER) 5 basis points (0.05%) to 2.35%. Powell was careful to emphasize that the change in IOER was a technical adjustment—not a policy decision—made to keep the effective fed funds rate within the set bounds. While the IOER is an active rate paid to banks for
excess capital, the upper-bound fed funds rate is the more appropriate rate to reference for policy. For now, that upper-bound rate has stayed constant.

CONCLUSION

Investors have become fixated on the idea of a rate cut, but we think lowering rates would be premature in this environment. There is still substantial global uncertainty, even as economic data have improved. The global economy is still early in recovery mode, and we have yet to
see a definitive resolution in U.S.-China trade talks. The Fed has faith in the U.S. economy, and policymakers understand the consequences of unnecessarily loosening policy. Right now, we see more evidence that inflationary pressures will pick up as global growth stabilizes over the next few months. If that happens, we think the Fed will lean toward raising—not reducing—rates.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted.

Investing involves risk including loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL
Financial LLC is not an affiliate of and makes no representation with respect to such entity

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

]]>https://salleywealthmanagement.com/a-high-bar-for-lower-rates-weekly-economic-commentary-may-6-2019/feed/0Off to a Strong Start | Client Letter | May 2, 2019https://salleywealthmanagement.com/off-to-a-strong-start-client-letter-may-2-2019/
https://salleywealthmanagement.com/off-to-a-strong-start-client-letter-may-2-2019/#respondFri, 03 May 2019 03:37:27 +0000https://salleywealthmanagement.com/off-to-a-strong-start-client-letter-may-2-2019/The S&P 500 Index has risen for four consecutive months, resulting in the strongest start to a year in more than 30 years!

]]>If it seems like the financial markets have been off to an unusually strong start to the year—you are correct. The S&P 500 Index has risen for four consecutive months, resulting in the strongest start to a year in more than 30 years! To be fair, the early gains included recovery from oversold market conditions in December, but a steady combination of monetary policy, economic performance, and corporate profitability have pushed the S&P 500 to record levels.

While we’re pleased with the new highs, part of our job at LPL Research is to keep an eye on what could temporarily disrupt solid market performance. As such, we emphasize three key areas when making investment decisions: market fundamentals, technicals, and valuation. A review of each suggests to us that the market can continue to provide longer-term opportunity, but with the possibility for shorter-term volatility. In any event, we will continue to emphasize the importance of diversified portfolio strategies for suitable investors to best take advantage of market conditions.

We remain encouraged by market fundamentals. U.S. economic data have been steadily improving in recent months, with signs of stabilization in manufacturing and gains in employment, personal spending, and business investment. In addition, the Federal Reserve appears set on keeping interest rates at current levels for the near future, allowing market interest rates and fiscal tailwinds to help support domestic activity. This has been a healthy offset to concerns of slowing global growth, with a potential U.S.-China trade deal remaining the wild card.

Market technicals, which include sentiment, pricing, and volume patterns, currently indicate solid momentum, while a variety of industry surveys suggests investors possess a healthy balance between appreciation and skepticism of the recent market gains. Although the S&P 500 recently hit a new high, it took more than six months to exceed its previous record set last September. Historically, when the S&P 500 has had at least a six-month “pause” between records, returns over the following 12 months were above average, which may indicate good news for summer markets.

Our third important criteria is market valuation. Rather than simply looking at the price-to-earnings ratio (P/E) when making equity investment decisions, we stress the importance of looking at the P/E relative to the current level of interest rates and inflation, which both remain well below historical averages. As a result, although the market may be trading at record levels, we don’t think it is overvalued.

It’s been quite a run for equity markets in the first four months of 2019. A quick review of market fundamentals, technicals, and valuation suggests a near-term pullback may be possible. However, suitable investors could use volatility as an opportunity to rebalance diversified portfolios or add to current positions to help work toward longterm investment goals.

We encourage you to contact your trusted financial advisor if you have any questions.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Economic forecasts set forth may not develop as predicted.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value
Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit

]]>https://salleywealthmanagement.com/off-to-a-strong-start-client-letter-may-2-2019/feed/0First Quarter’s GDP Surprise | Weekly Economic Commentary | April 29, 2019https://salleywealthmanagement.com/first-quarters-gdp-surprise-weekly-economic-commentary-april-29-2019/
https://salleywealthmanagement.com/first-quarters-gdp-surprise-weekly-economic-commentary-april-29-2019/#respondTue, 30 Apr 2019 04:59:42 +0000https://salleywealthmanagement.bradcable1.com/first-quarters-gdp-surprise-weekly-economic-commentary-april-29-2019/We’ve finally closed the book on what was one of the most perplexing quarters of this expansion.

We’ve finally closed the book on what was one of the most perplexing quarters of this expansion. In January and February 2019, economic data took an unexpected turn as trade and political headwinds weighed on global demand.Tensions then subsided in March, and signs of a rebound started to appear.

These past few months have been full of surprises, so it was only fitting that this chapter ended with a blowout gross domestic product (GDP) report. The April 26 report showed first quarter GDP increased 3.2%, the best first quarter gain since 2015 and above all Bloomberg forecasts for growth [Figure 1].

TRADE AND INVENTORIES

However, the components of first quarter output showed a weaker base under otherwise strong overall growth. Net exports (exports minus imports) contributed 1% to overall GDP, and inventories added 0.7%, accounting for more than half of last quarter’s gain in output. Both components have been volatile over the past few quarters amid the ongoing U.S.-China trade dispute.

Global trade volumes have fluctuated recently as purchasers have tried to time shipments around developments in trade talks. Exports jumped in January and February, right before the United States’ March 1 deadline for implementing higher tariff rates (a deadline that was ultimately nixed). Net exports’ contribution to last quarter’s GDP was its second highest in five years.

Inventory levels have swelled as U.S. companies have tried to avoid supply chain disruptions while preparing for a recovery in demand as trade tensions ease. Inventories have contributed an average of 1% to GDP growth over the last three quarters, above its average three-year contribution of just 0.1% to GDP.

Because of these factors, first quarter strength could simply be borrowing growth from future quarters. The swift rise in inventories over the past three quarters could reverse as companies start to work down current stockpiles, and net exports’ gain could eventually moderate as global trade activity normalizes. Trade and inventories have historically been volatile components of output, and big swings in both constituents have evened out in subsequent quarters.

CONSUMER AND BUSINESS SPENDING

The first quarter GDP report looks less impressive with trade and inventories stripped out. Excluding these volatile components, GDP increased 1.5% in the quarter, the weakest “real final sales” growth since the end of 2015. However, fundamentals suggest stronger growth may be ahead for both sectors.

Consumer spending added just 0.8% to overall GDP, its lowest contribution in a year. While weaker consumer activity is typical for the first quarter, even seasonally adjusted, sentiment and spending both took a noticeable hit last quarter amid a record government shutdown and an influx of negative global headlines. Global uncertainty has overshadowed an otherwise healthy job market and solid wage gains, which both point to an impending rebound in consumer spending. Consumer activity has already started to recover, evidenced by March’s biggest gain in retail sales since September 2017.

Business spending contributed 0.4% to GDP, its second-lowest contribution since the end of 2016. Companies have weathered the same headwinds as consumers, and the cumulative uncertainty has had a chilling effect on capital expenditures (capex). Muted growth in capex, especially recently, has been discouraging. Increased capital spending
is key to our economic outlook, as it leads to increased productivity and contained labor costs. Economic conditions also support a pickup in capex. Fiscal incentives for business spending are still in place, companies have benefited from robust profit growth in 2018, and investment in productivity has become more attractive amid
accelerating wages.

Fortunately, corporate demand has started to recover as global conditions have perked up. New orders for nondefense capital goods, our best proxy for future business spending, climbed the most in March since July 2018. We still think capital investment could help boost output in future quarters once companies get more clarity on trade and the global economic outlook.

U.S. stocks’ swift first quarter rally could also help lift growth, as rising stock prices lead to more confident consumers and businesses. The S&P 500 Index just capped its best quarter since September 2009, climbing 13.1% over the last three months. The benchmark index previously has posted returns that high in only 15 quarters since 1970. In the quarters following those high marks, GDP growth has accelerated by an average of 0.5% over the prior quarter.

CONCLUSION

A perplexing first quarter is behind us, and the U.S. economy escaped without a noticeable dent to output growth. First quarter GDP growth was unusually strong at first glance, but the devil was in the details. Trade and inventories were significant tailwinds, signaling to us that both components will likely drag on growth in the following quarters. But the contributions were timely, helping to get the economy through a rough patch with fundamentals pointing to higher consumer and business spending growth ahead. Overall, the report puts our forecast of about 2.5% GDP growth in 2019 well within play.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted.

Investing involves risk including loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by Any Government Agency | Not a Bank/Credit Union Deposit